GST Reforms in Real Estate

Fundamental changes have occurred in the concept of 'Works Contract' with the transition from the VAT era to the GST legal framework. During the Value Added Tax (VAT) era, goods manufactured on the basis of a contract, as well as constructions made on land as Immovable Property, were considered 'Works Contracts'. However, under GST law, 'Works Contract' is restricted only to contracts related to immovable property. In short, construction activities carried out permanently attached to land are considered 'Works Contracts' under GST law.

With the implementation of the GST law, a tax rate of 18% was generally applicable to works contract services. However, in situations where the transfer of property includes the value of an undivided share of land, the law provides that one-third of the total contract value shall be considered as the value of the land, and GST shall not be charged on that portion.

No GST on Undivided Share of Land (UDS)

In the transfer of construction services, land (Undivided Share of Land) and the building are usually sold together. However, according to GST law, the transfer of land is not considered a taxable supply under Schedule III.

Therefore, a system currently exists where the value of the land is calculated as one-third of the total transfer value, and tax is exempted for that portion. Consequently, even if the standard tax rate is 18%, the effective tax rate for construction transfers that include the value of land is only 12%.

Additionally, there are no restrictions on utilizing the Input Tax Credit (ITC). Meanwhile, GST is not applicable to sales that occur after receiving a Completion Certificate. These were the tax rates and related provisions that existed during the first two years of the GST implementation.

GST Rates - Residential Real Estate Project

In the financial year 2019-20, GST rates in the service sector were fundamentally revised. Effective from April 1, 2019, the maximum GST rate for construction services was fixed at 7.5%. After deducting the value of land (Value of Land abated), the effective GST rate is 5%.

Based on notifications effective from April 1, 2019, projects are classified under the RERA Act as RREP (Residential Real Estate Project) and REP (Real Estate Project), with different GST rates applied accordingly.

• RREP (Residential Real Estate Project): A project is classified as an RREP if 85% or more of the total carpet area of the real estate project consists of residential apartments.
• REP (Real Estate Project): If the residential apartment share is less than 85%, the project is considered a Real Estate Project (REP).

There is no difference in the tax rates for residential apartments between RREP and REP. However, a difference in tax rates does exist for commercial apartments within these projects.

For the transfer of residential apartments included in RREP (Residential Real Estate Project) and REP (Real Estate Project), the applicable GST rates are 1.5% (for Affordable Residential Apartments) or 7.5% (for Other than Affordable Residential Apartments).

When calculated after excluding the land value (land value abated), the effective tax rates that come into force are 1% and 5% respectively.

Affordable Apartment:

·         In Metro Cities: Units with a carpet area up to 60 sq. m. and a price below ₹40 Lakhs.

·         In Non-Metro Cities: Units with a carpet area up to 90 sq. m. and a price below ₹45 Lakhs.

  RREP Category: Commercial units included in the Residential Real Estate Project (RREP) category are subject to a 5% tax rate.

  REP Category: Meanwhile, a higher tax rate of 18% is fixed for commercial units included in the Real Estate Project (REP) category.

  Input Tax Credit (ITC): Although the tax rate is higher for REP, the benefit of Input Tax Credit is available for the sale of these commercial units.

The construction and transfer of flats in the construction sector often do not take place solely on the basis of a bilateral agreement. Instead of the developer owning the land required for the flat construction, the common practice is to commence construction activities based on a Power of Attorney obtained from individuals willing to provide their land.

In such transactions, it is customary to provide flats to the landowner in exchange for the value of the land. Since the flats handed over to the landowner are treated as a sale, the developer incurs a tax liability. To document these circumstances clearly, such transactions are often implemented through a tripartite agreement. In these types of agreements, the landowner is referred to as the Land Owner Promoter and the construction firm is referred to as the Developer Promoter.

The Developer Promoter must settle their tax liability by paying in cash itself; the benefit of Input Tax Credit (ITC) is not available to the construction company in this context.

At the same time, if the Landowner Promoter sells the flats received by them before obtaining the Completion Certificate, they will also be liable to pay tax. Since the flats provided by the construction company to the landowner in exchange for the land value are considered a "supply" under GST, the supplier is obligated to issue an invoice for said service. The landowner is entitled to the Input Tax Credit for the tax recorded on that invoice.

GST on Transfer of Development Rights (TDR)

The Power of Attorney granted by a Land Owner to a Promoter is considered a taxable service under GST law. This is known as the Transfer of Development Rights (TDR).

Tax Liability Breakdown:

·         Before April 1, 2019: The Land Owner was responsible for paying tax at a rate of 18% on the flats received in exchange for TDR.

·         From April 1, 2019: Under the Reverse Charge Mechanism (RCM), the responsibility to pay this tax shifted from the Land Owner to the Developer.

Conditions for Exemption and Payment:

·         Full Sale Before Completion: If all units are sold before receiving the Completion Certificate (meaning they are all treated as 'Taxable Supply'), the Developer will not have a tax liability under the Reverse Charge Mechanism for TDR.

·         Sale After Completion: For flats sold after obtaining the Completion Certificate, the Developer/Promoter must pay GST on the proportionate TDR under the Reverse Charge Mechanism.

This tax reform, implemented in the construction service sector, is also applicable to ongoing projects. For construction activities that commenced prior to 01-04-2019, an opportunity was provided to opt out of this new tax structure. To do so, it was sufficient to submit an option in Annexure-IV. Those who did not submit such an option will be considered as having migrated to the new scheme.

Calculations under Rule 42

Since 18% GST is applicable to commercial units in REP (Real Estate Projects), the construction company is eligible to receive proportional Input Tax Credit (ITC) as per Rule 42 of the CGST Rules, 2017. According to Rule 42, all input tax credits, excluding blocked credits, must first be treated as common credit.

The eligible Input Tax Credit for the area is calculated not on the basis of the price of the flats, but on the basis of the carpet area ratio of the residential and commercial units. That is, the ITC related to the commercial portion can be retained only in proportion to the carpet area of the commercial units relative to the total carpet area.

Simple and Beautiful

Low tax rates and a simplified tax structure are highly beneficial for the flat construction sector and for those aspiring to purchase flats. Through this, tax compliance costs are reduced, and transactions in the real estate sector become more transparent.

Additionally, even if the sale of flats takes place before obtaining the Completion Certificate, GST is collected as per the forward charge mechanism. On the other hand, for transactions occurring after the Completion Certificate is received, the related service tax reaches the government through the reverse charge mechanism. In this manner, the tax due to the government is legally ensured regardless of the stage at which the sale occurs.